Thursday, December 29, 2011

Will Extreme Weather Events Batter the Insurance Industry in 2012?

As I enjoy a snow free December in Chicago, it makes me ponder if payback will come in the form of extreme weather later in the season. My perception is that the weather is getting weirder and extreme weather events have become more frequent. However, a post by Anthony Watts suggests observational bias is responsible for my perception of an increase in extreme weather events. "With instant messaging, and Internet enabled phones with cameras now, is it any wonder that nothing related to severe weather or disaster escapes our notice any more?" On the other hand, Chris Field, director of the Carnegie Institution's Department of Global Ecology at Stanford University judges "We're seeing an increase in extremes of high temperatures, an increase in extremes of heavy precipitation, an increase in the length and severity of droughts.,"

Hurricanes in particular are a type of extreme weather event where my perception does not match reality. As destructive as Irene was, it is the only hurricane to have made landfall in the U.S. since 2008. The doomsday predictions about increases in hurricanes making landfall in the U.S. due to global warming have not come to pass. However, as a caveat, it is important to note that 2010 and 2011 were extremely active years for tropical storms. Favorable steering currents and wind shear kept all but Irene from hitting the U.S. 

There was a big spike in tornado activity in 2011, with over 1,600 tornadoes and 552 fatalities.  There are, on average, 1,300 tornadoes each year in the United States, which have caused an average of 65 deaths in recent years. The 552 confirmed fatalities from tornadoes in 2011 is the second-most tornado deaths in a single year in US history. Yet, one year of abnormal activity does not make a trend.

Flooding and Drought
The spring of 2011, particularly April, brought extreme weather and climate events to many parts of the United States. Tornadoes, flooding, drought, and wildfires ravaged the U.S. during the spring, and set numerous records. While similar extremes have occurred throughout U.S. history, never before have they occurred in a single month. Once again, at this point it is impossible to know whether this was a one year aberration or the start of an ongoing change in extreme weather patterns.

Predicting the likelihood of extreme weather events in 2012 is practically a litmus test for whether you believe in global climate change. For those that judge that global climate change is occurring, it probably makes sense to underweight property insurance companies in your portfolio. For those that are skeptical about the claims about global climate change, property insurance companies may offer a suitable investment opportunity.  

The KBWP ETF offers a vehicle for global climate change skeptics and believers to profit (or lose) from their views. Investors can buy or short this ETF. Other Property and Casualty Insurance ETF's include IAK, KIE, and PIC.

The case for going long property and casualty insurance companies is:
1) increased rates implemented due to heavy claims in 2011 will boost revenue. Policy sales rose to $115.7 billion in the third quarter from $111.1 billion a year earlier, according to Property Casualty Insurers Association of America.
2) the extreme property damage from tornadoes in 2011 was an aberration as it is unusual for tornadoes to hit highly populated areas. Tornado activity in 2012 is unlikely to strike so many highly populated areas.

The case for going short property and casualty insurance companies is:
1) global warming is causing an increase in tropical storms. The U.S. has been fortunate the last two years that   steering winds and wind shear have kept hurricanes from hitting the east and gulf coasts. However, our good fortune is unlikely to hold on for a third year. The devastation of Irene may be a precursor to an increase in violent property destroying storms.
2) Low interest rates and a challenging stock market will continue to put pressure on insurers’ investment income.

Related Posts
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